How important is it to choose the right mortgage term?
The process of buying a home usually starts with the buyers seeking a mortgage loan. There are many factors to be considered while looking for a new mortgage. These aspects of a mortgage are critical as they can decide how much you would end up repaying.
The interest rate, amortization period and the mortgage term, including the lender you approach are some of the aspects that can have an impact on the deal. However, the mortgage term has special significance as it offers a short-term view on your long-term mortgage obligation. The mortgage term, Interest rate and the amortization period are all linked together.
The interest is a part of the fee paid to use the lender’s money and can remain fixed for the entire duration of the mortgage loan. However, depending on the agreement between the lender and borrower, it can also vary. In such cases, the interest rate is set on a monthly or quarterly basis and depends on the market rates. It’s also the type of loan for which the interest rate will remain constant only for a given term and not for the entire duration, and the total sum put towards the loan itself will fluctuate, subsequently changing the principle amount of the mortgage.
It’s a scenario when the term of the mortgage and duration of the loan do not mean one and the same. The term primarily denotes the length of time that the interest rates are determined by, and typically vary from 6 months to 15 years. At the end of each term, the borrower either repays the loan in full or renews it, probably with a change in the terms and conditions.
On the other hand, the amortization period is the duration in which the borrower has to pay off the entire loan. The longer the period, the lower is the monthly installments, but it also takes much longer to repay the loan. It also culminates into an increase in the amount repaid over time.
Having a better idea about mortgage term will make it easy understand the balance between the four primary options available in the market, which include 10, 15, 30, or 40-year term. Let’s discuss each option in detail:
10-year mortgage: Designed for those who are willing to make a substantial down payment, this option has the advantage of significantly lower interest rates. Ten years denote a lesser risk for the lender, who in turn are willing to share their profits with the borrower by offering low rates. However, a significant disadvantage of the options is higher monthly payments, as the borrower is essentially choosing to pay off the mortgage in the least possible time. But considering the overall cost of the loan, which is the least with the 10-year term, it is ideal for those who have able to make a substantial down-payment upfront.
15-year mortgage: In terms of popularity, the 15-year mortgage term comes second to the traditional 30-year loan. It tries to combine the best of 10-year and 30-year terms, as it offers a notably lower interest rate than a 30 year, and lesser monthly payments than 10- year term. It can be a favorable option for people who do not wish to retain the property for more than 15 years.
30-year mortgage: Often considered as the option with minimal risk for the lenders, the 30-year mortgage is also the most popular with the borrowers. However, the homeowners would end up paying more in interest over the life of the loan, i.e., three long decades. It’s a good option for those who are willing to retain the estate for a long time and looking at its popularity it seems most of us do.
40-year mortgage: The option can make your dream of owning a lavish home come true and that too with low monthly payments. However, the interest rates are usually the highest in the 40-year term and with many uncertainties involved for the lenders, it turns out to be the costliest loan with interest included.
Based on informed calculations, the monthly payment for the 10-year loan can be more than twice as that of a 40-year loan and about twice of the 30-year loan. Yet, the 10-year option also results in more than four times lesser interest paid as compared to the 30-year loan and almost seven times in interest with a 40-year loan, in which you could end up paying more in interest than the initial worth of the house.